Is it time to scrap ‘independence?’
For comps and reviews, maybe.
Who really needs or wants an “independent” accountant, anyway?
Leading accounting firms are pushing a revamp of the rules for compilations and reviews that would drop the traditional ‘independence’ requirement and replace it, instead, with a new standard aimed at reliability. The idea has been cooking for a couple years, but it’s only now starting to get some buzz in the profession.
The AICPA’s powerful Accounting and Review Services Committee is now looking at the idea, pushed there by an ad hoc Reliability Task Force of the AICPA PCPS executive committee.
They’re working from a white paper titled “Consideration of an Alternative Framework for Compilation and Review Engagements,” which explains that the idea started in September 2003 when Accounting Horizons published a paper entitled “A Proposed Framework Emphasizing Auditor Reliability over Auditor Independence” coauthored by Mark H. Taylor, F. Todd DeZoort, Edward Munn, and Martha Wetterhall Thomas. While written as an auditor reliability framework, the AICPA PCPS task force says it believes that “the framework applies equally to any assurance or attest service.”
In their paper, the authors distinguish among independence, integrity, and expertise as key ethical constructs needed to achieve objectivity which in turn leads to reliability. They contend that while independence is important, it should not be the end game – reliability should. The authors’ assert that CPAs cannot be completely independent regardless of any rules because the client pays the audit fee. Further, CPAs can provide reliable services even though they are not entirely independent because reliability results from objectivity which in turn results from independence, integrity, and expertise.
In February 2008, the first the Reliability Task Force met for the first time, headed by David Morgan, chair of the AICPA’s Private Companies Practice Section (PCPS), with practitioners, preparers, and third-party users of compiled and reviewed financial statements. Two of the academic research paper’s authors were also.
The Task Force’s discussions produced an interesting distinction and hypothesis. Specifically, there is a difference between independence impairment caused by financial or relationship interests and independence impairments caused by the external CPA’s performance of certain services. This distinction had previously been communicated to ARSC by other users. For example, it is common for many small to medium firm CPAs to perform non-attest services for their business clients where the CPA performs certain internal control activities on behalf of their client. Many users perceive these types of services to be extremely valuable to many businesses that otherwise would be incapable of preparing accurate accounting books and records and quality financial statements. However, even though these services improve the reliability of the issued financial statements they might impair the CPA’s independence and disqualify the CPA from issuing a review report under current SSARSs requirements.
The traditional model for the performance of financial reporting engagements looks like this:
In this model, the client’s financial data are first processed through its internal control over financial reporting. The end result of that process is the preparation of financial statements. Those financial statements are then subjected to the CPA’s performance of audit, review, or compilation procedures. Third parties are then able to use the resulting report and financial statements in making decisions such as whether to make a loan or extend surety bonding.
But you won’t find that model very often in “real world.” It “is extremely difficult to achieve especially for smaller clients because they need their accountant to do more than simply compile, review, or audit their financial statements. To achieve reliable financial reporting, these clients need their accountant to perform certain nonattest services such as bookkeeping, payroll or other accounting services or certain other activities with respect to internal control over financial reporting”
The result, in reality, looks like this:
In this case, the external CPA’s service has intersected with some of the internal control functions that were reserved for the client in the traditional model. When this occurs the CPA’s independence, by definition, is impaired.
So what are the “reliability” supporters advocating?
The Task Force believes that, for compilation and review services, the public would be better served by a framework that focuses on the reliability of the financial statements. The financial reporting process may be enhanced by the performance of nonattest services by CPAs for their clients including those where the CPA performs control activities or other internal control procedures for their client. Maintaining a stance that accountants cannot express some level of assurance if they do not comply with the existing independence model (in which they play no role in the client’s internal control) is not practicable for some smaller entities.
The reliability framework stresses integrity as the foundation upon which all other ethical considerations follow. If the accountant has integrity, then he or she can assess the relationship with the client and whether he or she has the appropriate expertise to perform the applicable attest engagement. The Task Force believes that maintaining “relationship-based” independence (for example, an immediate family member of the CPA is not in a key management position at the client) and “financial-interest” independence (for example, no direct investments in the client) should, at a minimum, trigger reporting requirements in compilation engagements and should continue to be a precondition to  performing a review level service. On the other hand, the Task Force believes that if independence is impaired because the accountant performs certain nonattest services such as bookkeeping, payroll or other accounting services, or certain other activities with respect to internal control over financial reporting, the accountant should be able to still express limited assurance on the client’s financial statements provided they can demonstrate how they maintained their objectivity and provided reliable services. The Task Force also believes ARSC should be provided flexibility and latitude in its consideration of the appropriate performance and reporting requirements for compilation and review engagements.
Therefore, the Task Force recommends that ARSC proceed with the development of a Statement on Standards for Accounting and Review Services (SSARS) that would be based on a framework for the performance and reporting of compilation and review engagements where the maintenance of independence would not necessarily be a prerequisit. Instead, the new SSARS should stress that the accountant remains objective and strive to achieve reliable financial reporting.
Sounds like a bold move to update an ancient standard for the the real-world. Then again, what are the hidden dangers in abandoning “independence.” Would audits be next?
FREE DOWNLOADS: Recommendations of the Reliability Task Force (PDF, 10 pages) and Notes from the August 2008 ARSC meeting (PDF, 7 pages).
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This is rather interesting especially as Dr. Taylor was one of my college professors. I do think that any system needs to review the “tenants of the faith” so to speak and challenge their validity in the current environment. I would say that there is a good argument here that independence was a step on the road to reliability, but is it not always a necessary step towards reaching the best solution for the end user.
Shane: You make a good point. Maybe “independence” is an obsolete idea. Maybe what the “customer” really wants is “reliability”. But doesn’t this move us another step AWAY from being auditors and one step CLOSER to being insurors? I didn’t become a CPA to work as an underwriter of someone else’s risks. If so, let’s just throw away the idea of “assurance” and we can all get into “insurance.”
It’s a very interesting point. I think the fundamental flaw with the idea of complete independence is that the client is signing the check. Andersen didn’t want to lose the biggest client they had in Enron so there is pressure not to upset the client. When there is economic downturn and firms don’t want to loose client’s then there is pressure not to upset them or bring up too many issues. With this pressure if audit staff see an issue that can go either way, they will more than likely elect to pass on it to not upset the budget (or the partner).
Maybe it’s time that the profession becomes a truly independent government oversight function (at least for public companies)that can serve the public interest. Goverment auditors would be independent and fees can be based on revenue range. They could also try inserting CPA/CIA’s into public companies as part of management or Boards, but paid and employed by the govt. It’s time to entertain some radical ideas before we lose relevance.